Our Beloved Euro

The world seems to be lurching from crisis to crisis. For those old enough to remember, we had the misery of Black Monday in 1987 when the Dow dropped almost 23%. (It fully recovered in about 6 months to the chagrin of those who sold as the market plummeted.)

In the late 1990’s, Long Term Capital Management, a hedge fund whose board included two Nobel Prize winners in economics, had to be bailed out by the US government. The fund lost $4.6 Billion after betting on the Russian ruble just before the Russian financial crisis erupted. The fund was considered to be too large to fail. Some pundits opposed the bail out because bail-outs just encourage institutions to make risky decisions in the hope they will be rescued by government. (That sounds vaguely familiar.)

Then in 2000 everyone expounded at cocktail parties about the increasing value of their stock portfolios; no one could lose money on the market. The dot-com bubble then burst.

At the height of the bubble, Nasdaq peaked at 5132; today it is at 2346. Fortunately the general market has fared somewhat better than the technology stocks, most of which were trading on future promise rather than current performance. (I exclude Nortel which taught me a painful lesson as I held all the way down, being a loyal Canadian.)

With short memories and awash with cash, by mid 2008 investors scoured the world for opportunities. “Lazy money” was attracted, like moths to the fire, to any investment that would yield 7 - 10% and was rated relatively safe by rating agencies such as Moodys or DBRS. Lazy money is money owned by people who don’t want to do their homework by analyzing the risk and security of the investments they are purchasing. There were a lot of banks, pension companies and institutions who ended up with CDO’s and subprime mortgage portfolios that became illiquid and ultimately worth only a fraction of what they cost.

Today you can invest in the Euro and Greek bonds. Is Greece too big to fail. What is the credit rating for Greek bonds. Will Germany and France save Greece, then Portugal and Spain? What about all those rioters in Athens who think they will be entitled to their benefits forever regardless whether their government can afford to pay them. What happened to the rating agencies and the EU regulatory authorities when Greece issued bonds in 2008.

The headline reads:

“Goldman Sachs Group Inc. managed $15 billion of bond sales for Greece after arranging a currency swap that allowed the government to hide the extent of its deficit.”

And in the Saturday Globe and Mail, Business Section, May 15, Derek deCloet reflects on investors who are prepared to lend money to Britain (a holdout from the Euro) for 10 years at 3.74% or even worse for 30 years at about 4% simply because the rating agencies call their bonds “Triple A”. He writes:

“The biggest problem is that lazy money depends on rating agencies,” says one of the smartest debt investors I know. They shouldn’t, this person says: Rating agency analysts are typically underpaid, overworked, and the good ones are inevitably picked off by Bay Street or Wall Street firms that will pay them a lot more.

Here’s a modest prediction: Some time in the next several years, the rating agencies will be exposed again, this time by underestimating the risk in the government debt of some major economy. And, just as in the crisis of 2008-09, the investors who make the big money will be the ones who ignore credit ratings altogether and do their own homework.

I agree that we have to do our own homework, but I am really not sure how reliable my homework or my conclusions are. I predicted years ago the $US would fall because of the continuing deficit and balance of payment problems and increases, also the lack of political will to deal with entitlements. I even bought a hedge. I was right, but my timing was off. The hedge expired before I was in the money.

In 1979 the Hunt Brothers out of Texas cornered the silver market. Silver skyrocketed in price from about $5 to $50 per ounce in a year.  When silver was $45 I went to the only bank selling silver intending to buy some. I needed a bank draft which I did not have at the time. There were 30 or more people, some with paper bags full of cash, patiently waiting to trade it in for silver. I thought to myself, this is probably not a good idea. And I was right for once. One lesson I have learned is that investors generally like company – if lots of other people are buying something, it must be good. With the silver play, I was a contrarian.

I am not sure how to do my homework, but it is fun speculating! In the meanwhile, my daughter is going to school in Ireland which, unlike England, uses the Euro. So I did buy some Euro’s on Thursday. But I am going to stay clear of UK Bonds.